Dividend policyIn 2008, after 56 years, Sir Ken Morrison stepped down from the board of directors of Wm. Morrison Supermarkets, the business founded by his father in 1899. At the same time as Sir Ken gave his last statement as chairman, the board announced a new dividend policy: "We will target progressive dividend growth in the coming two years, over and above earnings growth, in order to bring dividend cover to a level in line with the rest of our sector."

The sector to which the board referred was "the European retail sector," where average dividend cover was 2.5 times, compared with Morrison's three times. As the table below shows, the company delivered on its two-year policy.

Metric

2008/09

2009/10

2010/11

2011/12

2012/13

Underlying earnings per share (EPS) growth (%)

16

23

12

11

7

Dividend per share growth (%)

21

41

17

11

10

Dividend cover

2.9 times

2.5 times

2.4 times

2.4 times

2.3 times

Following the bumper dividend growth of 21% and 41%, Morrison again increased the dividend by more than EPS in 2010/11. This reduced cover to 2.4 times, which the company said was in line with the European food retail sector average. At the same time, the board announced a new dividend policy: "We are committing to a three-year annual dividend growth of at least 10% starting in the new financial year. We will also rebalance the split between interim and final dividend payments to be c. 30:70 in the future."

Morrison has delivered on its dividend commitment in the first two of the three years.

What does the future hold?Morrison's EPS growth slowed to 7% during 2012/13, and in meeting its minimum dividend-growth commitment of 10%, cover reduced to 2.3 times.

Furthermore, the new year hasn't started well, and analysts see EPS actually falling for 2013/14 -- by 5%, to 25.85 pence from 27.3 pence. If the forecasts are accurate, and if the company increases the dividend by 10% (to 13 pence from 11.8 pence), cover would drop to just two times.

I think it's likely Morrison will deliver the 10% dividend rise for 2013/14, and complete the board's three-year commitment -- barring any major catastrophe, such as a disastrous Christmas.

However, looking beyond 2013/14, the company's new dividend policy looks sure to be considerably more conservative than the policies pursued in the recent past. Aiming to grow the dividend in line with EPS would put Morrison on the same hymn sheet as rivals Tesco and J Sainsbury.

I think Morrison will avoid any rigid commitment to a certain level of dividend or cover. Having strategically reduced cover so aggressively since Sir Ken's retirement, the directors would look immensely stupid if they ended up having to cut the dividend in the next few years.

Based on earnings and dividend forecasts for 2013/14, and a current share price of 264 pence, Morrison is on a price-to-earnings ratio of just over 10, and a yield of just under 5% -- by no means ungenerous, especially if business picks up again in 2014/15.

The Fab Five, which include a utility group "with nearly guaranteed returns," and a health-care company with "prodigious cash generation," are some of the highest-quality businesses you'll find within the FTSE 100.

G.A. Chester does not own any shares mentioned in this article. The Motley Fool recommends Tesco. The Motley Fool owns shares of Tesco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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